WorldCom Fraud Centered on Connection Costs

The accounting fraud at WorldCom ( WCOM) amounted to a decision by its ousted chief financial officer to categorize as long-term investments money paid to local phone companies to complete calls.

At the beginning of 2001, Scott Sullivan, who lost his job when the $3.8 billion scandal came to light this week, took that fateful decision after discovering that at least 15% of these connection agreements weren't producing revenue, The Wall Street Journal reported Thursday. Sullivan decided to capitalize the so-called "line costs" as long-term investments to be written down over time, hoping the agreements would start producing revenue later, the newspaper reported.

WorldCom shook corporate America Tuesday night by announcing it would be forced to restate five quarters of earnings statements to reclassify the expenses as routine costs. The revelation sent its stock down to pennies a share before it was halted by Nasdaq and prompted the Securities and Exchange Commission to file criminal charges against the former highflier.

The company's top accountant, Sullivan became a close ally of former WorldCom chief executive Bernard Ebbers in 1992 when Ebbers' company acquired Sullivan's Advanced Telecommunications Corp. The two shared adjacent offices until Ebbers was ousted by the WorldCom board in April.

According to the article, Sullivan's questionable bookkeeping was discovered several weeks ago during a routine internal audit by company accountant Cynthia Cooper, who alerted Max Bobbitt, the head of WorldCom's audit committee. Bobbitt is the director who took most of the heat for a $408 million personal loan the company made to Ebbers.

All told, Sullivan capitalized costs from $540 million to $797 million a quarter over five quarters. In May 2002, however, realizing that some of his revenue projections related to the line costs might not be realized, Sullivan began to contemplate a charge that would write down the expenses and reduce net income.

Quoting someone familiar with the matter, the Journal reported that the board was notified May 23 that a charge would include the line costs, but didn't signal how much it would be.

When the board finally called in its new auditors, KPMG, two weeks ago to review the accounting, Sullivan reportedly made an impassioned defense of his methods. Sullivan reportedly argued that because WorldCom wasn't receiving revenue, he could defer the costs of leasing the lines until they produced revenue. But KPMG officials weren't satisfied, citing accounting rules that clearly dictate that the costs of operating leases can't be delayed, the newspaper reported.

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